Product Market Competition and Agency Conflicts: Evidence from the Sarbanes Oxley Act

Abstract

We use the Sarbanes Oxley Act (SOX) as a natural experiment of a shock to internal governance to examine the link between product market competition and internal governance mechanisms. Consistent with the notion that product market competition is a close substitute for internal governance, we find that firms in concentrated industries experienced a larger improvement in operational efficiency after the approval of SOX than did firms in non-concentrated industries. These gains in efficiency appear to come from a significant reduction in production and administrative costs. Several robustness tests confirm that our main results are not driven by unobservable factors unrelated to changes in corporate governance.